Analysis: Eskom – this is not going to end well

Eskom’s recent pleas to Treasury for a R50bn equity injection (i.e. money that it will not have to repay) gives us a small insight into just how badly things are going at the parastatal. The R50bn requested is, according to the Eskom finance chief, Tsholofelo Molefe, the minimum required. It also wants to increase the tariff increases to the already above-inflation 8% recently determined by Nersa, the electricity regulator. Eskom says that the current tariff will leave it with a cumulative revenue shortfall of R225bn by 2018. By DIRK DE VOS.

This is probably the biggest crisis the country faces right now. Eskom supplies almost all the country’s electricity and is also, measured by its South African revenues, one of the biggest companies in South Africa. It is a crisis that is unfolding in slow motion right before our very eyes.

Eskom is in the middle of a R350bn capital investment programme, primarily The Medupi, Kusile and Ingula Pumped Storage Scheme, all of which has been hit by massive delays. This compounds Eskom’s position. As it raised debt to finance these projects, the interest payable amounts to around R29 billion per annum. At the outset, these projects, particularly Medupi and Kusile, which will cost R105bn and R120bn respectively, were far more expensive than international benchmarks measured on a per-MW basis. The delays have a snowball effect: firstly, in lost revenues that these plants could otherwise have generated, secondly in the approximately R2 billion it has had to pay Exxaro for coal not supplied to it and thirdly, in the price it has to pay for diesel to fuel stand-by diesel generators amounting to R10 billion in the previous year against a budgeted R3billion.

Treasury is in a bind: the South African government is already spending more than it receives in taxes largely due to a burgeoning public service salary bill. Our debt is now northwards of 40% of GDP and Eskom can only be funded directly by the government if South Africa increases its borrowings even further. By borrowing more, South Africa’s credit rating gets to be downgraded and we then have to pay more on our total debt. But we have no real choice. As all creditors know, there is a word for unpayable debt – it is called equity. There is another risk: at some point the electricity tariffs become so high that demand for electricity is affected, resulting in what are known as “stranded assets”, or assets that are under-utilised because the costs structures are too high. Less demand means that the total cost structure must be recovered from a smaller number of customers.

There are several reasons that float around as to why Eskom finds itself (and therefore everyone else) in this predicament. Some point to the delayed in building new capacity imposed by the Mbeki government, others point to poor management, political meddling, the massive electrification programme, constant changes in leadership, burgeoning staff expenses and even cadre deployment, all of which hollowed out the capacity of the utility to perform on its mandate. Eskom has offered its own reasons, including unreliable coal supplies and contractors that fail to achieve their deadlines. All of these reasons have different degrees of truth to them, but they do not provide a full answer.

The problem with Eskom lies in the way that it is structured. In 2000, when our country seemed more open to new ideas, Profession Anton Eberhard, an energy and infrastructure specialist at the University of Cape Town and now also a commissioner at the National Planning Commission, penned a paper entitled Competition and Regulation in the Electricity Supply Industry in South Africa for the then-recently established Competition Commission. Even 14 years later, this paper should be seen as required reading for anyone who has an interest in a stable supply of electricity.

In it, Professor Eberhard makes the telling point that in the 1990s it only appeared that Eskom was a well-run and efficient organisation. At that point, SA enjoyed the lowest prices for electricity in the world and the supply was reliable. Neither did it need government support and was able to issue its own debt or bonds to finance all its operations. The paper also points to perhaps Eskom’s biggest post-democratic achievement: the national electrification programme, something that now sits the centrepiece of the “good story to tell” narrative we are now hearing in the run-up to the elections.

Despite these achievements, Professor Eberhard suggested the introduction of market mechanisms, separating grid and generation, introducing privately owned generation and provided different options for how this could be done. Since Eskom appeared to be at the apex of its powers, these suggestions were simply ignored. But even then, he was able to show that Eskom’s apparent successes were actually at a cost to the economy. The low prices for electricity and the electrification programme were possible because of other factors such as very low coal prices, Eskom's exemption from taxation and dividends, financing subsidies (including subsidised SA Reserve Bank forward cover). It also maintained a large taxpayer-funded capital development fund. More importantly, he showed that by the 1990s, electricity consumers had already largely amortised most of the loans required to fund the generation over-capacity that existed because of the over-investment in generation plants in the 1980s.

The result of this is that Eskom effectively free-wheeled into the 21 century with no build programme, assets paid down and very little debt. But evidence of the current problems at Eskom was there to see and Professor Eberhard largely predicts the problems we now confront with Medupi and Kusile well before they were even conceived. The then most recently built power plant, Majuba, is also Eskom’s most expensive to operate. But Majuba's costs to build and operate could get lost in the mix. With a massively depleted balance sheet, this is no longer the case. Moreover, the problem is not just with generation. A recent Nersa audit of 18 municipal grids makes for grim reading.

One can only speculate what might have been had we restructured our electricity sector back then. This is not for lack of trying. This includes the failure to introduce regional electricity distributors, REDs. What is lost is lost, but we cannot afford to make any further mistakes.

Treasury has no choice but to plug the gaps and recapitalise Eskom, but if it is to do so while retaining the credibility of our creditors, it will have to do what we have long avoided – breaking Eskom up, separating grid from generation and inviting private sector investment both to take over existing power stations and to build new ones. Introducing some sort of competition and harnessing market-based mechanisms to control costs will also be important. Imposing some sort of discipline on municipalities to maintain their own infrastructure would also be helpful.

It is not that we do not know how to do this. The renewable energy programme has been successfully run by almost any measure and this provides the perfect template and dry run to scale it right up to base load power stations. The renewable programme also demonstrated that within Eskom there are many capable people who could make a real difference if their mandate was not to protect the interests of Eskom but to serve those of the country. These, for a long time, have not been the same thing. Almost every other modern democracy now has some form of market mechanisms in their electricity, we can no longer afford to stand alone.

Eskom’s problems are huge and because they are structural, they are not going to go away. The sooner we grasp this as a country, the better. We have squandered so much time and effort already; let’s not lose any more. If we fail to act now, we can be assured that this will not end well. DM

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